Disclaimer: Given Dodd-Frank, proxy plumbing and all those comments I want to provide the SEC, the report below doesn’t do the ICGN Mid-Year Conference justice. I wrote this up more than a week later with poor notes and memory. Comments, corrections and substitute photos are solicited.
The Financial Crisis Inquiry Commission will report in December to give an unbiased historical accounting of the causes of financial crisis. It will be out in book form but will also be available through download.
$11 trillion in wealth was wiped away. The market took until 1954 to get back to the levels of 1929. Let’s hope this one doesn’t take as long but, more importantly will we learn the lessons necessary to prevent or minimizes future bubbles?
It was a failure of accounting and deregulation. Too many were rewarded based on volume not on performance and their was no continuity in risk (they thought) after all the slicing, dicing and creative complexity.
Rewards can’t be asymmetric and function properly. This was not a natural storm; the clouds were seeded. Signs were there, such as a 2004 warning from the FBI about a housing fraud epidemic, but they were glossed over. Now, our remaining investment banks are largely trading banks, not focused on generating capital but on gaming the markets. The betting market is much larger than the real economy… with more than 85% of transactions being synthetic.
Dodd-Frank requires the investment banks to hold 5% of the securities they sell but I’m not sure what good that does since that portion of their business is now minor. We need to rethink the role of finance in our economy.
The real value of the forthcoming report might be in driving a cultural/ethical shift. Yet, swagger is growing among those in the financial services industry who see the recent financial crisis as a “perfect storm” that isn’t likely to reoccur. If they were too big to fail before, now it is ever more so, with only six investment banks left.
There was an obvious lack of oversight at corporate, especially bank, boards and Watson gave some good advice about further questions that need asked of auditors. I didn’t leave this session feeling especially hopeful.
Although institutional investors represented at the conference seem to be busy trying to address risk and the ICGN issued a paper on the subject (see Board Risk Oversight: Bridging the Corporate-Investor Governance Divide, Marcy Murninghan, 10/12/2010), reforms to date have been relatively minimal and their seems to be no international body that appears poised to move us in the right direction. How effective can institutions with investments in thousands of companies be in monitoring? More reason for at least weighted indexes and a small transaction fee on trades.
One catchy turn of phrase: “If it is growing like a weed, it probably is a weed.”
Borus – Dodd-Frank will eventually give us proxy access. Another important provision was SEC flexibility and authority on “any significant matter.” Coming proxy season could be return to more sparks but with the stay on proxy access, maybe not. Shareowners seem increasingly willing to vote against directors… trend. Say on pay will be at thousands of companies. Elimination of broker voting will sting. Majority vote requirements will be a battle by company and will be pushed by several members. Doesn’t see another wave of shareowner rights coming. Companies are more willing to talk to shareowners.
Seethoff – The fact that majority voting requirement was not contained in Dodd-Frank was very significant, as was movement of disclosure of clawback policies from voluntary to part of listing standards. Boring is good from our perspective. In evolution – more empowered boards. Changed dynamic from issuer side as less confrontational. Sees this as at least long cycle. Hard for directors to get any profound understanding at big companies because of scale and scope. John disagreed with insulation. Still have withhold vote against directors individually.
Proxy plumbing may lead to more accurate counting, ability of companies to communicate directly with shareowners (disintermediation), and address role of proxy advisory firms.
Siciliano – “Volker rule” in Dodd-Frank important, even if watered down. Say on pay vote can insulate board — that’s the unintended consequence. Political optics. Insulation and talking about the wrong stuff. There is still a tendency to resist providing access to board members. More forums are needed where investors and board members interact.
Friedman – hard to tell how bad pay plans are in advance; much easier after the fact.
Moving Beyond Words: lessons learned on best ways to implement ESG.
Daniel Malan – As we look over the last 10 years, we see that “nonfinancial ” risks led to huge financial problems.
Malan sees the Global Reporting Initiative as a good start in standardizing reporting and expressed hope that by 2020 such measures will be better integrated into normal financial reporting. King made comply or explain mandatory. King III integrated reporting is now required. Sees GRI as good minimum framework… a minimum level should be mandatory with lots of room to disclose more. Emphasized tie with pay, independence and diversity of boards, engagement with stakeholders and integrated reputation.
Ann Byrne – Surveyed members and found many have incorporated nontraditional measures within stock picking and other strategies.
She mentioned several, including related party transactions, systems of substandard management, cost of carbon emissions, minimizing risk. Proxies for assessing management. Data is still insufficient in many areas so they are working with management groups to arrive at templates. These would be starting places but each company will need their own metrics. Emphasized need to establish a vibrant community, focusing within and transforming workforce.
Suzanne Fallender – Asked rhetorically, why report when nobody reads? Sees a primary value in just going through the drill, looking back at data and comparing with prior years to see progress.
Tone at the top is critical but is is also extremely important that middle managers become champions for their group. Need to look at what gets rewarded and recognized. They are integrating the information into their 10-k reports but aren’t getting a lot of questions from analysts. They’re most likely to ask questions about energy efficiency of products vs other direct climate change strategies. Emphasized what we should be asking, skills, diversity, risks assessed, innovation, education.
Integrating Sustainability Related Performance Targets into Remuneration Policies: cause for scepticism or success? Erik Breen, Head of Responsible Investing, Robeco, The Netherlands; Robert McCormick, Cheif Policy Officer, Glass Lewis, USA; Rob Lake, Head of Sustainability and Governance, APG, The Netherlands; Moderator: Carl Rosen, Executive Director, ICGN, UK
Rosen announced ICGN implementation of “country correspondents,” which might serve as especially good resources when members are getting into various markets. Current correspondents include: Heloisa Bedicks, IBGC, Brazil; Rients Abma, Eumedion, Netherlands and Amy Borrus, CII, USA.
McCormick – If sustainability isn’t compensated, it won’t be a concern for priorities. What is sustainability? Continued access to oil or safety and environmental performance? We need the proper incentives… for example, size of spills vs number of spills. In the US many are beginning to put in reports but the incentives are too short-term. Don’t limit to single item. Should reflect value to owners.
Lake – Shell linked about 15% of cash bonus to ESG performance, moved to a single measure and then dropped off the Dow Jones Sustainability Index. Doesn’t like one limiting to measure. There have been a flurry of examples over the last 18 months in the aftermath of the financial crisis. Consulting firms in US may not be big on it but at least one Dutch firm is promoting. It needs to be an integrated approach and the amounts have to be enough to be meaningful.
Breen – If you don’t meet your target, you shouldn’t get the reward. Many are linking pay and sustainability in the Netherlands. Emissions targets, oil spills? He recommends taking a broad approach. The strategy should be up to each company. If I heard right, 39% surveyed in Netherlands had links between ESG and pay; 29% of Euro 100. Invited to Amsterdam to observe. External independent measures are needed. Dig into relationships among people and buy specialized research. The methodology shouldn’t overshadow the what.
During Q&A George Dallas mentioned some of the work being done by F&C in this area. (perhaps on their responsible engagement overlay)
Principles for Responsible Investment discussed by Donald MacDonald, Trustee & Chairman of the BT Pension Fund, discussed before the lunch break.
He spoke of the need for social and ethical aspirational principles. Minimize externalization of costs. Society has an interest in promoting universal ownership. (Universal Ownership: Why environmental externalities matter to institutional investors
PRI has grown rapidly from 100 signatories to over 800, representing $25 trillion. Discussed PRI Engagement Clearinghouse, which is designed to help address collective action problem by providing a private online forum for signatories to pool their resources and influence, and seek changes in company behavior, policy or systematic conditions. PRI is moving from just listed companies to a broader base of concerns, including “trade liberalization” and the internationalization of capital in light of increased risk of systematic failure.
We need to better define what we expect from our financial services partners. What did we miss? Lack of alignment, due diligence on credit and derivatives. Boards should understand what they are investing in or don’t do it. (see also, Top Firms Cause $2.15 Trillion a Year in Environmental Damage, The Corporate Library, 10/13/2010)
Warren Buffett interviewed by Nell Minow. (video)
Minow could easily have another career as an interviewer. Both appeared very much at ease in a wide ranging conversation that moved from Buffet’s work as a voice in the secret millionaires club to getting the right CEO. One selling key for kids is the word secret… magic to kids and I’ll bet it works well on adults too. With regard to picking CEOs, the secret isn’t in the contracts; they must love the business. Berkshire has an entrance strategy, but no exit strategy. Their holding period is forever. He went on to discuss several of his 13 Owner Related Business Principles.
Given the recent talk of shareowners meetings being a waste of time and the growing shift to virtual-only meetings, it was good to hear Buffett describe his desire for fully informed shareowners and his marathon annual meetings. He advised avoiding bad businesses, agreed with Minow that CEO ego index (stadiums and such as named monuments) is a bad sign.
BH has no compensation committee and it only takes him 15 minutes to make those decisions. Doesn’t pay for industry growth. They don’t make earnings projections. Ratcheting up proxy rules should help ratchet up competitiveness but the best way to effect typical boards is to embarrass them in the press. Envy is a bigger motivator for many CEOs than greed.
Institutional investors could dramatically increase their effectiveness by concentrating on the simple few and if the top five investors in companies would speak together on outrages. Minow offered that when she talks to the press about outrageous pay, she names the members of the compensation committee but they rarely include them in their write-ups… too worried about offending management.
BH has no liability insurance for directors who get paid $900/year to serve. Buffett thinks board members should have a downside, as well as an upside. CEOs that bring down society should have to start over again after going broke. None of the CEOs who contributed to our latest financial crisis moved out of the top 1% in wealth. They are still getting bonuses as if they earned their bailout. Board members should have also paid a penalty.
Buffett doesn’t see liquidity as a plus but as part of the casino mentality. Advises getting away from minute by minute coverage and gambling. BH removes their managers from such distractions, preserving momentum around the essential business.
Public pension funds: the challenges to managing portfolio risk in an era of high market volatility. Scott Evans, TIAA-CREF; Farouki Majeed, CalPERS; Marco Geovanne Tobias da Silva, Previ, Brazil; Moderator: Christianna Wood, Chairman, ICGN.
Majeed – Asset allocation was the primary means of risk management at CalPERS for many years when the fund was designed around a more stable environment. Risk got on the board’s agenda in 2007. Now, there is an ad hoc board committee and an enterprise risk manager is coming. Indicated his belief that they need to do a better job tying incentives to risk.
Tobias da Silva – Said pension funds are very regulated in Brazil… focused mostly around government bond but earning double digit returns. 60% is in equities. Volatility during the financial crisis and since has gone up only slightly. Previ has few exotic assets. The board sets guidelines for allocation, risk, risk management, etc. Here was the kicker… They don’t provide extra compensation to the money managers and they don’t outsource. The challenge is their surplus
Evans – One key is having your own experts. Believes there should be independence between asset management and risk management. At TIAA-Cref they appear to be having constant battles but the dialogue results in better long-term performance. The entire senior management committee meets regularly as a risk committee looking at long-term risk adjusted return over a five year period. Whereas the ICGN Corporate Risk Oversight Guidelines have the chief risk officer reporting to the board, Evan thinks better to report CEO. I’m not a fan of imperial CEOs but this makes sense to me. Risk evaluation should be part of day to day operations and boards should be involved at the policy level. Evans noted that liquidity risks are a wake-up call. (I assume this was during a discussion around the flash crash.)
Jay Lorsch – Conducted interviews of corporate board members. HBS website working knowledge. Perspectives from the boardroom 2009. Both financial and nonfinancial companies
- Growing complexity of companies.
- Hard time understanding role of board. (each board has to figure out their own detailed responsibilities)
- How to acquire better understanding of their company’s business and industry.
- Maintain sound relationship with management.
- Oversee company strategy.
- Assuring management development and succession. Improving risk management. (many felt if do the others, this will mostly get taken care of) Put in place proper mechanisms but can’t get into the weeds on specifics. They won’t get a direct handle on the risk themselves. Right structures and processes.
Board can only oversee what management is doing. If management isn’t doing anything, the board can’t oversee. Compensation so complex that many don’t understand how they drove the behavior that caused risky behavior. Simply the Pay Problem – about incentivized risky compensation (paper)
Charles Macek – Clear delineation between board and mgt. Mgt runs the company. Ultimately, board must own risk, can’t just delegate. Enrue right CEO. Work with to create value. Oversight. Biggest power is to hire and fire the right CEO. Succession is something good board should focus on all the time. Average time spent in US is 2 hours per annum but that is the biggest duty. All their CEOs were internally recruited. Engagement is largely around say on pay but broadens out from there. Culture important. Recognition far more important than pay to CEOs. Gripes by directors in Australia. Amount of time spent on compliance. Short-termism of markets. In Australia rotate around country. Also web-cast. Questions if there shouldn’t be an investor briefing meeting.
Bob Walker – ESG, resource extraction because primarily invested in Canadian companies. Only by attending AGM that they often meet board members. Boards look too much like management. Wants more diversity on boards. Need directors with human rights and environmental management expertise. Also uses proposals for engagement. From shareowner’s perspective is knowing the culture. Resources challenges. Trying to get companies to driving towards ESG metrics. Get away from purely financial to other metrics that may demonstrate longer-term focus. Bizarre outcomes and complexities re say on pay. Asked about virtual-only very hesitant to advocate for.
See also, coverage by Dave Roberts, Pension Funds’ Odd Incentives, Cal Watchdog, 10/12/2010; ‘Pension-fund socialism”: class clash evolves, Ed Mendel, Calpensions, 10/13/2010; Buffett Say Buyout Funds ‘Don’t Know the Business’, BusinessWeek, 10/8/2010; ESG roundup: ICGN risk oversight guidelines, Carbon Disclosure Project, IPE, 10/8/2010; Board Risk Oversight: Bridging the Corporate-Investor Governance Divide, Marcy Murninghan, 10/12/2010. Also of interest, New GRI office helps US companies showcase sustainability.